Friday, January 7, 2011

What United spends its money on - the definitive guide

This is the second in a series looking in detail at Manchester United's finance. In December I wrote about the various sources of revenue the club has. This post looks at operating costs. Revenue minus operating costs equals the famous "EBITDA" (earnings before interest, tax depreciation and amortisation). I will write separately about the costs that come below EBITDA, namely those relating to player transfers and of course interest and related charges.

Compared to the complexity of revenues, the costs involved in running a football club are pretty straightforward. The cost of the playing squad and coaching staff dominate the total expense bill. Whilst wages have always been the single largest cost, their explosive growth in recent years have made them even more important. By way of illustration, in 1998/99 when United won the Treble (paying out significant bonuses in the process) wages represented 50% of total operating costs. In the most recent year, 2009/10, wages had risen to 73% of total costs. Over the eleven years since the Treble, United's wage bill has grown 356% or 12.2% per year. A staggering £959m has been paid in wages, bonuses, social security costs and pension contributions. It has been a good time to be a Cheshire Ferrari dealer.

As with revenues, the 2006 Investment Memorandum (the "2006 IM") provides a breakdown costs (£114.6m) in 2005/06 and I have used this document along with recent report and accounts to analyse the club's cost base.

The following table shows the split in 2005/06 and my estimates for 2009/10 (the totals for staff cost, other club costs, Red Football and MUTV costs are actual reported numbers, only the splits are estimates):

Wages and salaries

In 2005/6, player wages, bonuses and social security (National Insurance) costs totalled £61m or just over half the cost base. Directors were paid £2.6m and other staff (including of course Fergie and his coaching team) cost £20.7m (18% of the cost base). The report and accounts for 2010 do not give such a full split, but looking at the various subsidiary accounts (see footnote) it is possible to estimate the split of the 2009/10 total wage bill of £131.7m. On my estimate player costs have risen by two thirds over the four years (13% per annum). The accounts show directors' remuneration has increased 47% (10% per annum). On the assumption that other non-coaching staff costs have risen with inflation, the cost of Sir Alex and his coaching staff has risen c. 40% (9% per annum).

The 13% per annum increase in player wages is far greater than the Glazers had expected when they published the 2006 Investment Memorandum. In that document they only forecast player salaries to rise 6.6% per annum. In total, the actual 2010 wage bill is 21% higher than forecast only four years ago. This hasn't proved to be a problem because revenues have also grown far faster than expected (almost all due to better than expected TV deals). United's enviable wages/turnover ratio hasn't budged (see graph):

This massive increase in staff costs is not of course unique to United. We do not yet have figures for 2009/10 for Liverpool and Chelsea but the graphs below shows how all the major clubs have seen wage inflation running at very high levels over the period (City's wage bill increase is not of course "inflation" in the same sense).

Other club costs

The 2006 IM identifies three other types of cost.

"Matchday variable costs": these relate to the expenses of running Old Trafford itself and clearly will alter from year to year depending on the number of games played. In 2005/06 there were 27 home games meaning each one cost around £470,000. In 2009/10, there were 28 home games played in a bigger stadium (consuming more power, needing more security and staff etc, etc). Taking inflation and the stadium expansion into account, I estimate each home match now costs around £750,000 (this tallies with figures for a reduction in variable costs due to fewer home games given in the 2009/10 full year results presentation).

"Other variable costs": this includes travel for the squad and coaching staff. This fluctuates depending on where United go on pre-season tours and how far they progress through the Champions League.

"Fixed costs": everything else! This element appears to have risen very sharply over the last four years. I have two theories about this, firstly that this includes some of the (non-staff) costs of the club's Pall Mall commercial operation (such as rent and fees paid to intermediaries on commercial deals) and secondly that "fixed costs" may include player image rights. United and other clubs claim that image rights are not income, but rather commercial arrangements with players. HM Revenue and Customs dispute this and there is a case slowly chugging through the courts at the moment that will determine who is correct. The January 2010 bond prospectus gave an insight into the scale of image rights payments by United. The prospectus said that in the event of HMRC winning any future litigation against the club, there may be a liability of £5.3m relating to the employer's NI not paid on image rights from 2000-10. Employer's NI is around 12% and so that figure would imply total image rights payments of c. £44m over the ten year period, equivalent to 4.6% of the published wage bill. The accounting treatment of such payments is not clear, but I find it unlikely that the club accounts for them under "wages and salaries" when it is so adamant that they are "commercial" payments. This could be where they sit.

Red Football costs

Since the takeover Manchester United Limited (the old plc) has had a parent company, Red Football Limited. This entity needs its own auditors, lawyers, bankers etc and costs around £1.2m per annum.

MUTV

In 2006, MUTV was not consolidated into United's accounts. Since ITV's one third stake was acquired in November 2007, it is consolidated as a subsidiary. MUTV's operating costs for 2008/09 (the last year on which it has reported were £4.7m.

The future

Cost growth of 12% per annum is very high for most industries but not a problem if income growth keeps pace. For Manchester United, the even faster growth in revenues over the period has meant that EBITDA margins have actually risen from 30% in 2005/06 to 35% in 2009/10. The questions for the future are whether costs will continue to rise as quickly as they have over the past few years and whether revenue growth can continue to outstrip cost growth.

The principal driver of football wage growth has been the explosion in the value of TV deals. Put simply, players, agents and managers demand a share of the growing cake and generally they get it. The chart below shows how the two years when United's wage bill increased the most in the last decade (2002 and 2008) were years when new higher value Premier League rights deals came in. By contrast the three year deal beginning in 2004/05 (when Sky bid alone for domestic rights) saw a reduction of 18% in the value of domestic rights compared to the previous deal and it is noticeable that wage growth was very low during this period.

The most recent premier league deal covers 2010/11 to 2013/14. Although international rights were sold for more than double the value of the 2008-10 deal, a very small increase in domestic rights and changes in parachute payments means that each Premier League club will only see a c. 10% increase in PL TV income. In addition to this slowdown in media growth, many commentators expect the looming UEFA Financial Fair Play rules to dampen wage pressure across Europe as clubs look to bring costs in-line with income. This seems logical, but so far there is little sign of it.

United's 7% increase in staff costs in 2009/10 vs. 2008/09 is worrying as the increase happened despite lower bonuses (we didn't win the league or reach the Champions League Final as we did in 2009) and also despite the departure of Ronaldo and Tevez. This trend was further confirmed in the first quarter figures for 2010/11 which saw staff costs rising 14.8% compared to the previous year. This first quarter figure is particularly surprising given that it didn't include Wayne Rooney's much publicised pay rise (I appreciate one shouldn't read too much into one quarter's numbers). If press reports about Rooney doubling his salary from £90k to c. £180k per week are correct, he alone will drive up United's wage bill by 3.5% this year.

It isn't just United who are seeing very aggressive increases in player costs. Arsenal (probably the most prudently run major English club) warned in their 2009/10 report and accounts that "...there continues to be very strong upward pressure on players' wage expectations." Some of this pressure is the "City effect" of course and is likely to dissipate, but it is striking that despite Financial Fair Play, player salaries continue to grow at double digit rates....

Thoughts

There are two schools of thought about football's runaway costs. Some (like NESV, who bought Liverpool last year) believe that UEFA's new rules will naturally end the arms race in player salaries. If the biggest clubs have to breakeven or face a ban from European football then costs will have to rise in line with revenues or even fall for a period. That view certainly tallies with the actions of Chelsea who have trimmed their playing squad and allowed expensive older players to leave on free transfers. The other view is that so few clubs will meet the Financial Fair Play criteria that the rules will be fudged and that things will continue as they are. The Rooney-United tussle ended with the player winning the battle and another £4m+ being added to the salary bill showing the jury is out.

Why does any of this really matter? I think it's important for United fans because where we go from here will be a big determinant of what the Glazers decide to do with our club. The fact that costs have risen so much faster than expected since the takeover hasn't mattered so far because revenue growth has been even better. If revenue growth stalls in the future (and there is little TV or Matchday growth left if any) AND costs continue to rise, that could mean profits have also peaked and it may be time to sell....

LUHG

Footnote:

Estimating the wage split

The separate accounts of Manchester United Limited ("MUL"), Manchester United Football Club Limited ("MUFC") and MUTV give us some detail on who is paid what.

Of the £131.7m total salary bill, MUL pays £19.8m and MUFC (which employs all the players, ground staff and ticket office staff) pays out £111.9m. MUL pays for its Directors (Gill et al) and also pays for the MUFC board (Sir Bobby Charlton etc).

We can deduce from these figures that Fergie and the coaching staff must be employees of MUL, otherwise the average MUL salary for the 179 non-directors/MUTV employees (including 64 people employed in catering) would be an implausible £70k each.

I have had to estimate (using various press reports) what Fergie and the coaching staff earn and have come up with a figure of £6m. People may think this is too high or low, but at 4.5% of total staff costs small errors are not material.

Using this estimate, gives an annual cost of £38,500 per head for the all the admin, ticket office, Pall Mall, catering and ground staff.

This leaves the princely sum of £101m for the 68 players on the club's books in 2009/10 (£1.49m pa or £28,600 per week). That of course is an average.